Disclaimer: Any opinions expressed, potshots taken, or scientific views articulated are mine, and need not represent the opinions, potshots, or scientific views of the Federal Reserve Bank of St. Louis, or the Federal Reserve System.

Wednesday, January 18, 2012

Fed Salaries

This New York Times article is interesting. The author argues that the Fed now looks like a hedge fund, but Fed officials are not paid like hedge fund managers, and it goes from there.

This part is not quite on track:

The main difference between a hedge fund and the Fed is that the Fed effectively creates its own money, so it doesn’t have any borrowing costs, meaning yet more profits.

This is effectively the "creating money out of thin air" argument, which many people are confused about, including Sarah Palin. All financial entities create liabilities out of nothing, and buy assets. That is certainly not a distinguishing feature of the Fed. What makes the Fed different is its monopoly on a particular kind of circulating liability - currency. Otherwise, the Fed is a financial intermediary which issues liabilities - mainly currency and interest-bearing reserves - and holds assets. Why the author of the NYT article thinks the Fed looks like a hedge fund is that it intermediates across maturities, and much more so recently. The average duration of the assets in the Fed's portfolio has lengthened considerably since the financial crisis. Intermediating across maturities is considered risky, just as operating a hedge fund is risky. However, in the case of the Fed, the risk is borne by taxpayers. If short-term interest rates increase, then the Fed's profits fall, so the Fed has less to hand over to the Treasury, which has to make up the difference.

There are also some things in the NYT article about Fed salaries, which are certainly low relative to hedge fund salaries. Further, Fed salaries of top officials in the Fed can be lower than academic salaries. Ben Bernanke was probably earning more at Princeton than he is in Washington.

Here's a useful point:

Even so, people in private industry argue that you have to pay top dollar to get the best people and that the market demands it.

We even see this argument being made by the federal government. The regulator who oversees Fannie Mae and Freddie Mac, Edward J. DeMarco, has asserted that he had to pay the top six executives at Fannie and Freddie more than $35 million in combined pay over 2009 and 2010. He said that to do otherwise would be “irresponsible” because it would fail to retain and attract the appropriate people. Yet, the Fannie and Freddie executives are arguably doing even less sophisticated work than the Federal Reserve employees do.

Why these executives should be paid more than Mr. Bernanke and his colleagues defies reason. This is government work now.

Governors serve for 14 year terms. I believe that Congress can remove them from office for malfeasance. Reserve Bank Presidents serve, at most, two 5-year terms at the pleasure of their Boards of Directors.

http://www.federalreserve.gov/aboutthefed/bios/board/default.htm

http://www.federalreserve.gov/aboutthefed/bios/banks/default.htm

"...how does the Fed evaluate performance at those levels (Board member or regional FRB president)?"

Actually, the difficulty is not in getting rid of Board members or Presidents, it is keeping them.

The Governors, in particular, make the same salaries as Congress but don't have the same sort of prestige. Because the Governors have almost all had successful political or academic or business/banking careers, they can make much more on the outside. They often serve for a few years and then move on. It is a boring job.

Thus, very few Governors actually serve their full, 14-year terms.

Incidentally, quite a few of the Governors and Presidents know all about private sector incentives that you describe. Governor Warsh, for example, was a Vice President and Executive Director in Morgan Stanley's Mergers and Acquisitions Department.

1. The latter one was misbehavior of a guy on the Board of Directors of the New York Fed. What does that have to do with the performance of people working at the Fed and what they get paid?

2. For the top Fed officials, there would be a problem if it were too easy to fire them on the spot - Bernanke for example. Independence of the Fed from Congress is important. However, in New Zealand, the Governor of the Reserve Bank can be dismissed for failing to meet his or her inflation target. That's not a crazy thing. When I mentioned that "officials" can be fired, I was thinking about lesser ones than the Governors or the Regional Fed Presidents. It's possible for a regional Fed President to fire a Vice President, for example.

Very interesting article. I would highlight this phrase:"These disparities show that compensation, like people, is a complicated issue. People are willing to forgo earnings for prestige and other benefits like job security."

It comes very handy providing I am actually writing a paper on the link between mean earnings and earnings volatility across sectors of the US economy. For instance, Finance sector is much more volatile than the Government and, according to our preliminary results; the premium for a risk averse worker for bearing that risk could be as high as 36% on average. (http://myweb.uiowa.edu/gcubas/files/CubasSilos-slides-Dec2011_BB.pdf)

You have to ask why Ben Bernanke would rather run the Fed than work at Princeton, or why Charles Plosser would rather be a Fed President than a business school Dean, or work on Wall Street. It certainly can't be the current salary that these people find attractive, as they are all taking salary cuts relative to the best alternative. You might think that bigger salaries await them after they leave these jobs than they would otherwise get. However, some people will serve very long terms as Fed Presidents and then retire - Gary Stern at Minneapolis for example. There's something about having power that motivates people, I think.

"What does that have to do with the performance of people working at the Fed"

Integrity is an important part of performance.

And for you to suggest it was one guy is disingenuous, given we know that the Board leaked material, non-public information to its buddies (just as the previous Treasury secretary did).

Regarding firing top officials - does anyone think Arthur Burns did a good job? And if not, was he sanctioned? I think the answers are "no" to both questions. Put differently, the Fed monumentally screwed it up, but there were no adverse consequences for the decision makers. Just for the economy and the public.